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Renuka Sane, Anjali Sharma & Susan Thomas: The causes of NPAs

The court does not have the power to address the root cause of the non-performing asset problem, which lies in faulty economic policy

The Supreme Court is the latest entrant into the banking crisis, with a demand for names of defaulters. This is suo moto action by the Supreme Court, prompted by the public outrage about the costs to the public imposed by the Indian banking system. But solutions to India's banking crisis lie in legislative and executive action. It is the government, which strategises financial sector policy and owns public sector banks, and the Reserve Bank of India (RBI), which oversees banks in great detail, who should be held accountable for the banking crisis and must find solutions to it.

The Supreme Court order for defaulter disclosure appears to be a case of overreach. The original dispute made no demand for defaulter information from the RBI. The job of a court is to adjudicate disputes: hear both sides, weigh the evidence, deliver a judgement, in an efficient and timely manner. If there is no clear link between the disclosure order and the case at hand, the disclosure order has only added costs and delays, and thus diminished the performance of the court.

Even if we admit some merit in the order, what can the Supreme Court do to solve the banking crisis? The court does not have the power to address the root cause of the non-performing asset (NPA) problem, which lies in faulty economic policy. For example, the court will not be able to resolve bottlenecks that have caused defaults and rising debt, such as environmental approvals and land acquisition that cause project delays. Such powers rest with the executive and the legislature. Further, having the powers does not guarantee a solution, much less an optimal one. A holistic analysis is needed, to identify the root cause of the problem, and to design a comprehensive and effective solution. The Supreme Court does not have technical expertise required. For an analogy, in the past, the Supreme Court's interventions in economic matters such as environmental pollution and coal block auctions were poorly designed.

At the heart of the matter, bad debts at Indian banks are a combination of poor bankruptcy laws, weak regulations and a dominance of public sector ownership of banks. A focus on fixing only one issue - poor bankruptcy laws - led the legislative to enact a series of laws empowering banks as creditors to recover dues in bankruptcy. But despite passing a series of laws, (The Recovery of Debts due to banks and Financial Institutions Act, 1993; The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; regulatory mechanisms including CDR, 2002, "5/25" and SDR, 2015), NPAs continued to rise.

Recently the government tabled the Insolvency and Bankruptcy Code, 2015, a consolidated law with provisions that cover all debtors and all creditors. This is an example of the sort of change that is required, change that cannot come from the Supreme Court.

The next question that we should ask is: Why have Indian banks persisted in making losses when giving loans? Giving out some bad loans is intrinsic to the business of banking. Banking regulation must write down rules about recognising bad loans and have enough equity capital to pay for losses. This must be accompanied by capable supervision to ensure that banks live by these rules. These functions were carried out by the RBI, and there were many shortcomings in what kinds of rules were made and how they were enforced. The RBI may have collaborated with banks in hiding bad news through initiatives like Corporate Debt Restructuring (CDR).

Our banking crisis is rooted in the behaviour of banks, of the RBI (which regulates them in minute detail), and of the Ministry of Finance (which controls the board and the management of banks, and has overall responsibility for the strategy of financial sector policy). Since 2007, experts in finance have developed technical knowledge about how to a build stronger banking system. This knowledge should be used to reform RBI as the micro-prudential regulator of banks.

The next aspect for reform is processes to deal with bank failure. Generally in India, when banks in India get into trouble, there is a cover-up with costs forced on taxpayers; banks are not allowed to fail. A transparent framework to deal with bank failure is an integral part of a transparent framework to deal with systemic crisis. These issues have been addressed by the draft law proposed by Justice Srikrishna's Financial Sector Legislative Reforms Commission. Along with the draft Insolvency and Bankruptcy Code, this draft Indian Financial Code must also be tabled and implemented, in order to address the banking crisis at its root cause.

Finally, we must recognise the failures of government ownership. Just as the government resolved the problems of UTI in the late 1990s, a full work plan must be developed for the government exiting as the dominant shareholder of banks. In the Indian experience, we have seen that private banks work better. A wider shareholding will demand better accountability from RBI, as shareholders stand to lose money when banks are poorly regulated. Cohesive executive action is also needed to de-bottleneck projects and reduce the financial distress in the corporate sector.

What role did the judiciary play in the banking crisis, and hence, what is required of the judiciary in solving it? The Supreme Court can accept the role that judicial delays and mounting pendency plays in causing poor bankruptcy outcomes. These in fact, have become the safety mechanism for wilful defaulters. Winding up a company can take four to 10 years, BIFR proceedings can run for four to five years. Civil court proceedings on issuing or enforcing orders for recovery have gone on for 20 years. Better bankruptcy outcomes require that a mechanism is implemented to separate court administration and the judicial function. This is the only matter in India's banking crisis where the Court has jurisdiction and expertise to bring corrective interventions. Such intervention will have a higher impact in reducing NPAs in the Indian banking sector than demanding the names of the defaulters.


Anjali Sharma and Susan Thomas are at IGIDR, Mumbai. Renuka Sane is a visiting professor at ISI, Delhi

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Business Standard
177 22
Business Standard

Renuka Sane, Anjali Sharma & Susan Thomas: The causes of NPAs

The court does not have the power to address the root cause of the non-performing asset problem, which lies in faulty economic policy

Renuka Sane, Anjali Sharma & Susan Thomas 

Renuka Sane, Anjali Sharma & Susan Thomas

The Supreme Court is the latest entrant into the banking crisis, with a demand for names of defaulters. This is suo moto action by the Supreme Court, prompted by the public outrage about the costs to the public imposed by the Indian banking system. But solutions to India's banking crisis lie in legislative and executive action. It is the government, which strategises financial sector policy and owns public sector banks, and the Reserve Bank of India (RBI), which oversees banks in great detail, who should be held accountable for the banking crisis and must find solutions to it.

The Supreme Court order for defaulter disclosure appears to be a case of overreach. The original dispute made no demand for defaulter information from the RBI. The job of a court is to adjudicate disputes: hear both sides, weigh the evidence, deliver a judgement, in an efficient and timely manner. If there is no clear link between the disclosure order and the case at hand, the disclosure order has only added costs and delays, and thus diminished the performance of the court.

Even if we admit some merit in the order, what can the Supreme Court do to solve the banking crisis? The court does not have the power to address the root cause of the non-performing asset (NPA) problem, which lies in faulty economic policy. For example, the court will not be able to resolve bottlenecks that have caused defaults and rising debt, such as environmental approvals and land acquisition that cause project delays. Such powers rest with the executive and the legislature. Further, having the powers does not guarantee a solution, much less an optimal one. A holistic analysis is needed, to identify the root cause of the problem, and to design a comprehensive and effective solution. The Supreme Court does not have technical expertise required. For an analogy, in the past, the Supreme Court's interventions in economic matters such as environmental pollution and coal block auctions were poorly designed.

At the heart of the matter, bad debts at Indian banks are a combination of poor bankruptcy laws, weak regulations and a dominance of public sector ownership of banks. A focus on fixing only one issue - poor bankruptcy laws - led the legislative to enact a series of laws empowering banks as creditors to recover dues in bankruptcy. But despite passing a series of laws, (The Recovery of Debts due to banks and Financial Institutions Act, 1993; The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; regulatory mechanisms including CDR, 2002, "5/25" and SDR, 2015), NPAs continued to rise.

Recently the government tabled the Insolvency and Bankruptcy Code, 2015, a consolidated law with provisions that cover all debtors and all creditors. This is an example of the sort of change that is required, change that cannot come from the Supreme Court.

The next question that we should ask is: Why have Indian banks persisted in making losses when giving loans? Giving out some bad loans is intrinsic to the business of banking. Banking regulation must write down rules about recognising bad loans and have enough equity capital to pay for losses. This must be accompanied by capable supervision to ensure that banks live by these rules. These functions were carried out by the RBI, and there were many shortcomings in what kinds of rules were made and how they were enforced. The RBI may have collaborated with banks in hiding bad news through initiatives like Corporate Debt Restructuring (CDR).

Our banking crisis is rooted in the behaviour of banks, of the RBI (which regulates them in minute detail), and of the Ministry of Finance (which controls the board and the management of banks, and has overall responsibility for the strategy of financial sector policy). Since 2007, experts in finance have developed technical knowledge about how to a build stronger banking system. This knowledge should be used to reform RBI as the micro-prudential regulator of banks.

The next aspect for reform is processes to deal with bank failure. Generally in India, when banks in India get into trouble, there is a cover-up with costs forced on taxpayers; banks are not allowed to fail. A transparent framework to deal with bank failure is an integral part of a transparent framework to deal with systemic crisis. These issues have been addressed by the draft law proposed by Justice Srikrishna's Financial Sector Legislative Reforms Commission. Along with the draft Insolvency and Bankruptcy Code, this draft Indian Financial Code must also be tabled and implemented, in order to address the banking crisis at its root cause.

Finally, we must recognise the failures of government ownership. Just as the government resolved the problems of UTI in the late 1990s, a full work plan must be developed for the government exiting as the dominant shareholder of banks. In the Indian experience, we have seen that private banks work better. A wider shareholding will demand better accountability from RBI, as shareholders stand to lose money when banks are poorly regulated. Cohesive executive action is also needed to de-bottleneck projects and reduce the financial distress in the corporate sector.

What role did the judiciary play in the banking crisis, and hence, what is required of the judiciary in solving it? The Supreme Court can accept the role that judicial delays and mounting pendency plays in causing poor bankruptcy outcomes. These in fact, have become the safety mechanism for wilful defaulters. Winding up a company can take four to 10 years, BIFR proceedings can run for four to five years. Civil court proceedings on issuing or enforcing orders for recovery have gone on for 20 years. Better bankruptcy outcomes require that a mechanism is implemented to separate court administration and the judicial function. This is the only matter in India's banking crisis where the Court has jurisdiction and expertise to bring corrective interventions. Such intervention will have a higher impact in reducing NPAs in the Indian banking sector than demanding the names of the defaulters.


Anjali Sharma and Susan Thomas are at IGIDR, Mumbai. Renuka Sane is a visiting professor at ISI, Delhi

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Renuka Sane, Anjali Sharma & Susan Thomas: The causes of NPAs

The court does not have the power to address the root cause of the non-performing asset problem, which lies in faulty economic policy

The court does not have the power to address the root cause of the non-performing asset problem, which lies in faulty economic policy The Supreme Court is the latest entrant into the banking crisis, with a demand for names of defaulters. This is suo moto action by the Supreme Court, prompted by the public outrage about the costs to the public imposed by the Indian banking system. But solutions to India's banking crisis lie in legislative and executive action. It is the government, which strategises financial sector policy and owns public sector banks, and the Reserve Bank of India (RBI), which oversees banks in great detail, who should be held accountable for the banking crisis and must find solutions to it.

The Supreme Court order for defaulter disclosure appears to be a case of overreach. The original dispute made no demand for defaulter information from the RBI. The job of a court is to adjudicate disputes: hear both sides, weigh the evidence, deliver a judgement, in an efficient and timely manner. If there is no clear link between the disclosure order and the case at hand, the disclosure order has only added costs and delays, and thus diminished the performance of the court.

Even if we admit some merit in the order, what can the Supreme Court do to solve the banking crisis? The court does not have the power to address the root cause of the non-performing asset (NPA) problem, which lies in faulty economic policy. For example, the court will not be able to resolve bottlenecks that have caused defaults and rising debt, such as environmental approvals and land acquisition that cause project delays. Such powers rest with the executive and the legislature. Further, having the powers does not guarantee a solution, much less an optimal one. A holistic analysis is needed, to identify the root cause of the problem, and to design a comprehensive and effective solution. The Supreme Court does not have technical expertise required. For an analogy, in the past, the Supreme Court's interventions in economic matters such as environmental pollution and coal block auctions were poorly designed.

At the heart of the matter, bad debts at Indian banks are a combination of poor bankruptcy laws, weak regulations and a dominance of public sector ownership of banks. A focus on fixing only one issue - poor bankruptcy laws - led the legislative to enact a series of laws empowering banks as creditors to recover dues in bankruptcy. But despite passing a series of laws, (The Recovery of Debts due to banks and Financial Institutions Act, 1993; The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002; regulatory mechanisms including CDR, 2002, "5/25" and SDR, 2015), NPAs continued to rise.

Recently the government tabled the Insolvency and Bankruptcy Code, 2015, a consolidated law with provisions that cover all debtors and all creditors. This is an example of the sort of change that is required, change that cannot come from the Supreme Court.

The next question that we should ask is: Why have Indian banks persisted in making losses when giving loans? Giving out some bad loans is intrinsic to the business of banking. Banking regulation must write down rules about recognising bad loans and have enough equity capital to pay for losses. This must be accompanied by capable supervision to ensure that banks live by these rules. These functions were carried out by the RBI, and there were many shortcomings in what kinds of rules were made and how they were enforced. The RBI may have collaborated with banks in hiding bad news through initiatives like Corporate Debt Restructuring (CDR).

Our banking crisis is rooted in the behaviour of banks, of the RBI (which regulates them in minute detail), and of the Ministry of Finance (which controls the board and the management of banks, and has overall responsibility for the strategy of financial sector policy). Since 2007, experts in finance have developed technical knowledge about how to a build stronger banking system. This knowledge should be used to reform RBI as the micro-prudential regulator of banks.

The next aspect for reform is processes to deal with bank failure. Generally in India, when banks in India get into trouble, there is a cover-up with costs forced on taxpayers; banks are not allowed to fail. A transparent framework to deal with bank failure is an integral part of a transparent framework to deal with systemic crisis. These issues have been addressed by the draft law proposed by Justice Srikrishna's Financial Sector Legislative Reforms Commission. Along with the draft Insolvency and Bankruptcy Code, this draft Indian Financial Code must also be tabled and implemented, in order to address the banking crisis at its root cause.

Finally, we must recognise the failures of government ownership. Just as the government resolved the problems of UTI in the late 1990s, a full work plan must be developed for the government exiting as the dominant shareholder of banks. In the Indian experience, we have seen that private banks work better. A wider shareholding will demand better accountability from RBI, as shareholders stand to lose money when banks are poorly regulated. Cohesive executive action is also needed to de-bottleneck projects and reduce the financial distress in the corporate sector.

What role did the judiciary play in the banking crisis, and hence, what is required of the judiciary in solving it? The Supreme Court can accept the role that judicial delays and mounting pendency plays in causing poor bankruptcy outcomes. These in fact, have become the safety mechanism for wilful defaulters. Winding up a company can take four to 10 years, BIFR proceedings can run for four to five years. Civil court proceedings on issuing or enforcing orders for recovery have gone on for 20 years. Better bankruptcy outcomes require that a mechanism is implemented to separate court administration and the judicial function. This is the only matter in India's banking crisis where the Court has jurisdiction and expertise to bring corrective interventions. Such intervention will have a higher impact in reducing NPAs in the Indian banking sector than demanding the names of the defaulters.

Anjali Sharma and Susan Thomas are at IGIDR, Mumbai. Renuka Sane is a visiting professor at ISI, Delhi
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